By Beatrice Bedesch – Thanks to the shale oil revolution, the US is set to become one of the leading oil producing countries in the coming years. But with a global 0.5 per cent sulphur cap for marine fuels imposed by the International Maritime Organisation (IMO) coming into force on 1 January 2020, and global oil demand likely to reach its peak in the next decade, it won’t all be plain sailing for the US oil industry. Here, Hedgeweek discusses the prospects and challenges ahead with Doug King (pictured), CIO of RCMA Asset Management…
HW: How do you view global macro risks for oil production for the remainder of 2019?
DK: It’s been a pretty wild year so far geopolitically. The big issue has obviously been the Iranian situation, with Libya thrown in too. Yet, in the background, US oil production has seen continued growth and is over-performing to compensate for some of those global supply losses.
There remains much oil taken off the market due to geopolitical issues, so right now there are many unknowns.
HW: What about price levels expectations for 2019?
DK: Oil demand growth in 2019 will be driven, not by Western economies, but rather by continued economic activity in emerging markets, particularly from China and India. However, global growth is slowing. The US/China trade war continues, and business investment has been weak.
Another drag is the strength of the US dollar against these local emerging market currencies.
Clearly there can always be an escalation on the geopolitical side. Yet, it is very hard to be very bullish on oil demand growth in 2019 until the above factors are reversed.
Oil prices are high, but they are somewhat artificially high on the back of OPEC cuts and geopolitics, so the upside is limited. It would be difficult for the world’s oil consumers to handle much more than USD75 per barrel before demand destruction sets in.
To expect prices to rise steadily to USD85-90 per barrel is wishful thinking unless there are further serious supply side losses. Don’t forget, we also have SPR (Strategic Petroleum Reserves) in the US that hold nearly 700 million barrels of oil to offset short-term outages.
HW: Looking specifically at the US, what levels of production do you expect will be reached in the coming years?
DK: We expect US crude production to reach 13 million barrels per day by the end of 2019, most of which is onshore Permian basin production.
With the increasing involvement of oil majors in shale production that we’re seeing now, such as the takeover battle between Chevron and Occidental for Anadarko, we expect operational efficiencies and economies of scale to improve.
HW: When is US production going to peak and what do you expect peak production levels to be?
DK: We expect US production to reach 20 million barrels per day in the next five years, but peak production is not going to happen in the foreseeable future. The shale revolution only really started in 2010-2011 so we’re still only building out the basic infrastructure. The US is continually improving its knowledge of these tight oil basins and this is showing up in the upward revisions of US oil reserves.
HW: How is this going to affect the global oil supply balance? Is the US going to achieve an increasingly central role as an oil supplier?
DK: Currently global production is at 100 million barrels per day, with the US producing close to 13 million barrels per day. It will go to 20 million barrels per day in the coming years, and I don’t see much growth in other areas of the world apart from Iraq and maybe Canada. OPEC meanwhile, if it wants to operate as a cartel, will be under pressure to cut production in order to defend price targets. With global demand close to peak in 10-15 years amid increased electrification, and with US production increasing, the role of the US as a global supplier is paramount.
HW: What do you expect will be the break-even oil price for new upstream projects in the US in the coming years? How does that compare with new projects in the other main exporting countries?
DK: If WTI is at around USD55/ per barrel, production growth should be strong. If it drops below USD50 per barrel people will be more conservative, while north of USD60 per barrel they would be pretty happy with any project.
US shale is generally quite competitive cost-wise. In comparison there are some deepwater projects in Brazil, some in West Africa that are quite competitive, and the Middle East is still very cheap.
But from an investor’s point of view, rather than going out and spending a fortune in deep sea or sizeable upstream projects, it is going to be very interesting to see the rate of development and production in the US now that the majors are bedding down.
HW: What impact do you expect coming from a stepping up of decarbonisation efforts across the world? How is that going to impact refining capacity?
DK: The new IMO 2020 sulphur cap is obviously a big event, which will lead to demand destruction for low quality fuel oil. There will be increased demand for cleaner marine gasoil to meet the IMO sulphur cap. But the new fuel standards for global shipping are still wholly reliant on fossil fuels.
Refiners will be tested in their ability to break down the unwanted higher sulphur fuel oil.
There is recognition globally that fuel standards are tightening both on the road and at sea. Investors in new refineries are building bigger, but also much more complex, operations. Asia has built capacity at the fastest rate, with China at the forefront and on its way to becoming more of a highly complex tolling refiner for the rest of Asia and beyond.
HW: What technology developments are going to mostly disrupt oil markets in the coming years and why?
DK: There are many changes happening at the technological level, but certainly the rise of electric cars is one that is going to disrupt the oil market. What is going to be more interesting is what type of road transport is disrupted first, whether passenger vehicles, which are more gasoline orientated, or diesel-dependent commercial vehicles.
Yet, the tech advances in electric vehicles must not stall as the economics of electric vehicles must always offer a compelling advantage over its traditional alternative.
Eventually this will lead to a phase out of diesel and gasoline-fuelled cars, starting in urban areas. Emerging markets are going to be behind this compared to Western countries; China, for example, would love to have more electric mobility to reduce pollution. So definitely we’re going towards a trend of peak oil demand globally in 10-15 years.